Posted by: Paul Hewitt | November 27, 2009

Traders DO Need to Know the Direction of Manipulation

Information Aggregation and Manipulation in an Experimental Market Robin Hanson, Ryan Oprea, David Porter

This study looks at price accuracy in experimental (laboratory) markets, where there are price manipulators.  The overall finding is that non-manipulative traders compensate for the bias inherent in the offers from manipulators, by setting a different threshold for trading.  The authors acknowledge that the “identification of manipulation in the field is difficult” and empirical evidence is scarce and tenuous.  Hence the need for a controlled, laboratory experiment.  For background on the experiments, please refer to the original paper.

There were two parts to this experiment.  In the Replication Treatment, there were no manipulators present, and in the Manipulation Treatment, one-half of the participants were given an incentive to increase the median price at the close of the market.  All participants knew that half of their number had this incentive to manipulate, and they knew the direction that the manipulation would take (upward). Where the non-manipulative traders knew that the manipulative traders would attempt to bid up the price in the market, they lowered their threshold for accepting offers, effectively counteracting the manipulative influence in the market. This makes intuitive sense, but only in the case where the non-manipulative traders know the direction of the manipulation.

In my previous post, I indicated that it would be necessary for the non-manipulative (“informed”) traders to know which direction the manipulators would try to move the market.  Robin Hanson commented that this is not necessary.  I think he is wrong, now, but he was right when this paper was written!   I think the authors are saying that it is required.  In fact, in the paper, they go a step further and allow all participants to know the strength of the incentive to manipulate.  We should keep in mind that, while this experiment demonstrates the concept of market manipulation and whether it can have a persistent effect on market prices, it is a pretty simple, controlled example.  The real question is whether it can be generalized to more complex, real-world situations.

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Responses

  1. […] Paul Hewitt: […]

  2. I pointed you to two experiment papers. In this one subjects knew the direction, in the other one they didn’t. The theory paper says direction isn’t needed, or is the amount. That paper just assumes knowledge of the *distribution* over manipulator desires.

  3. In this paper (published earliest), the non-manipulators need to know the direction of the manipulation, so that they are able to compensate for this in their acceptance of potentially manipulated bids. This is logical and seems quite reasonable to me.

    In the other experimental market paper, the non-manipulators do not need to know the direction of the manipulation. In this case, the manipulators *were* able to manipulate the market price, but *only* in an upward direction. Perhaps there is a natural upward bias that the informed traders are unable to eliminate? At any rate, it shows that the bias is *not* fully eliminated, when the direction is not known.

    Perhaps it is a case where, despite the incentive to become better informed, they are unable to obtain enough information to determine the market correction required.

    However, the *observers* are able to compensate for the bias. As I indicated in my post, this appears to be evidence of another decision model being employed by the observers, and the paper gives little insight as to how they are able to adjust the manipulated market price to develop an accurate forecast.

    It also begs the question that if the observers are able to develop this useful decision model, why weren’t the non-manipulative traders able to do so too?

    Furthermore, we don’t know why they only see fit to make adjustments to the upward manipulation attempts (which *had* affected the market price), while leaving the downward manipulation attempts unchanged (correctly).

    So, based on the two laboratory experiments, it appears that the direction of manipulation must be known for the market price to be “accurate”. Observers, however, are able to make compensating adjustments to their forecasts even if the direction of manipulation is not known.

    Given these findings, I don’t know that a theoretical result using a highly-simplified model would change my mind about the need for non-manipulators to know the direction of the attempted manipulation.

  4. […] some limited evidence, the insistence on traders needing to know the direction of manipulation isn’t too compelling since the direction will be manifest insofar as the price is […]

  5. […] maybe manipulators can game these markets.  I think they can, as explained here, here, here and here.  These references apply to several points that follow regarding manipulation of speculative […]


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